Tax Prospects Lift Rates and Dollar Ahead of Weekend

The US Senate approved a budget resolution that is a necessary step
toward using a parliamentary maneuver that prevents the Democrats to block tax
reform by filibuster.
  This has
helped spur dollar gains against all the major currencies and nearly all the
emerging market currencies. The US 10-year yield is extending this week’s
rise.  It was up four basis points on the week coming into today, and it is up another four basis points
today, to once again approach the upper end of its six-month range.  

While parliamentary maneuvering by the minority party was a threat, since the attempt(s) to repeal and
replace the Affordable Care Act, the biggest challenge lies in the differences within the majority party. 
The Senate vote and the House agreement to vote on that bill as well shows
greater coordination.  We caution
that there are many moving parts and many details that have yet to be worked out and time is of the essence for
the debt ceiling and spending measures.

Politico initially reported that
Trump was leaning toward Powell to succeed Yellen at the Fed’s helm. 
Bloomberg is reporting that Trump’s advisers were encouraging Powell or Taylor.
Previously, reports indicated than Treasury Secretary Mnuchin favored
Powell.  PredictIt has Powell drawing ahead at a little better than a 2:1
favorite.  Yellen is second at about one-in-six chance. Taylor has slipped
to a one-in-seven chance.

The notable move this week regarding
Fed expectations was not just who will get the nod, but terms of the trajectory
of Fed policy.
  The implied yield on
the December 2017 Fed funds futures contract rose a single basis point this
week to 1.27%.  Our work suggests fair value, assuming no chance of a hike
in November and fully discounting a December hike, is 1.295%.  The more
significant change took place in the December 2018 contract.  Its’ implied
yield rose six basis points to 1.68%.  This
means that one hike next year is fully discounted.  The Fed’s forecasts suggest
that three hikes may be appropriate.

The market has also been confident of a Bank of England rate hike next
We have been less convinced on
the grounds that
this is not the first time or even the second time that
Governor Carney and the MPC have sounded as if they were prepared to hike and
then pulled back, and that the price cycle is peaking as the economy is
slowing.  Now, MPC member Cunliffe has joined Ramsden injecting a little
more doubt in the market’s mind about the timing of the move.  The yield
of the December short sterling futures contract did test a two-week lower today
was have recovered and is now down one basis point on the week.

Germany’s Merkel provided UK Prime Minister May with a glimmer of hope. 
Merkel’s comments were among the most positive from officials that progress is
being made and hold out the possibility (likelihood?) that sufficient progress
will be made to take talks to the next stage.  It appears that a greater
financial commitment from the UK could get the ball rolling.

The Catalonia confrontation with Madrid saw a new front open. 
There was an attempt to spur a run on deposits on several banks.   Spanish
stocks are underperforming.  Major bourses are higher, but Spain is off
slightly.  Financials are outperforming slightly.  Spanish bond
yields are a basis point higher, on par with Italy and faring better than the
core bonds where yield are three-four basis points higher.  Spain’s
10-year yield is up eight basis points this week.

The resilience of US equities yesterday with early losses completely
recouped by the closing bell may have impressed Asian investors.
Hang Seng recouped more than half of yesterday’s losses with a 1.2% advance
today.  Similarly, the Hang Seng
China Enterprises Index rallied 1.8%
today after falling 2.3% yesterday.   Japanese shares extended their
run.  The Nikkei has advanced for fourteen consecutive sessions through
today, while the Topix was up at its
tenth session.  The 0.7% gain in the
MSCI Asia Pacific Index was a sufficient cushion for the losses over the past
four sessions, and the regional benchmark
is up 0.2% for the week its third weekly

Japan goes to the polls this weekend.  The issue is not whether
Abe’s LDP wins.  The issue is the margin of victory, and if the coalition
can hold on to its super-majority.  The stronger the showing, the more likely the market concludes
that the continuity of policy means that Kuroda would likely be the first
Governor in a generation that serves a second term.

The euro’s two-day advance is being
  Initial support is pegged in the $1.1770-$1.1780 area, which needs to be taken out
to signal a new challenge on the key $1.1660 area.  That said, the
intraday technical indicators suggest this is not going to happen today. 
Sterling fell to a new low for the week just below $1.3090 but has since recovered to test $1.3160.  The intraday
charts warn it may run out of steam shortly.   The dollar edged through
the high from October 6 against the yen to trade at a new three-month
high.  With the US yield already at the upper end of its range, a new
impetus may be needed to lift the greenback much more against the yen.

There are large options expiring today.  There are a billion
euros struck at $1.18 and $1.1855 that expire today.  There are roughly
$450 mln struck at JPY113.00 and JPY113.50.  

The broadly stronger US dollar is also evident within the dollar bloc. 
The Canadian dollar is fairing the best, down almost 0.2%.  The Australian
dollar was nearly flat for the week coming into today
but is down 0.4%.  The New Zealand dollar has been sold through the
$0.7000 support and is down 0.75% today to take the week’s decline to
2.8%.  Investors continue to digest the unlikely political coalition
between Labour and the New Zealand First Party.  A two-year tend line has been violated and the low from earlier this
year is near $0.6820.


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